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Has the Recession Increased the NAIRU? William T

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Has the Recession Increased the NAIRU? William T Has the Recession Increased the NAIRU? William T. Dickens* Northeastern University and The Brookings Institution ABSTRACT The increase in job vacancies over the last two years has not been accompanied by a decline in unemployment. When this has happened in the past it has coincided with an increase in the NAIRU. Despite some qualifications as to why it might not be appropriate to view the recent increase as indicating such a shift, I use updated data to estimate the model developed in my 2009 paper that links movements in the Beveridge curve (the trade-off between job vacancies and unemployment) and the NAIRU. That exercise suggests that the NAIRU has risen from about 5% before the most recent recession to 5.8% in the first quarter of 2011. I then consider possible explanations for this outward shift including the persistence of high rates of long-term unemployment, extended unemployment benefits, a mismatch of skills between the unemployed and available jobs, and geographic mismatch exacerbated by problems in the housing market. I find little evidence to support the view that an increase in the level of long-term unemployment in the U.S. will lead to an increase in the NAIRU, but no strong evidence against the hypothesis either. A review of the evidence on the impact of extended unemployment benefits suggests that they probably have played a significant role in increasing the NAIRU, and the best estimates could explain the entire increase. Analysis of data on unemployment rates and vacancy rates by industry suggest that it is unlikely that skills mismatch has played an important role in the increase in the NAIRU. Similar evidence on geographic mismatch also calls that explanation into question. A number of recent papers have examined the extent to which problems in the housing market may be responsible for very low labor mobility that might be causing geographic mismatch. Most of the evidence suggests that this is not currently a problem though it is possible it could become more of a problem when the economy begins to pick-up. I conclude that while the NAIRU has probably increased, that is unlikely to be an important consideration for monetary or fiscal policy for some time. I also comment on the role that aggregate demand management and monetary policy could play in reducing some of the problems that might be causing the increase in the NAIRU. An earlier version of this paper was presented at an academic advisory meeting of the Board of Governors of the Federal Reserve on October 12, 2010. June 29, 2011 * Thanks to Tess Forsell, Marie Lekkas, Elizabeth Meyer, Shaun O’Brian, and Irena Tsvetkova for their help in preparing this paper. Thanks also to Christopher Foote, Jeffrey Fuhrer, Robert Trieste, and participants in seminars at Northeastern University and the Federal Reserve Bank of Boston for comments on earlier work. Introduction Starting with Blanchard and Summers (1987) it has been observed that there is a tendency for unemployment to remain high in some countries after a recession. In a series of papers, Lawrence Ball (1997, 1999, 2009a&b) has suggested that in most OECD countries the NAIRU increases after each recession. An exception, at least in the past, has been the United States. Here the unemployment rate has returned to levels that prevailed before recessions except during the period of rising unemployment in the 1970s. Ball has suggested that the reason for U.S. exceptionalism in this matter is the aggressive counter cyclical policy that the Federal Reserve has pursued to fulfill its dual mandate of stable prices and full employment. Ball also points to several cases where countries other than the U.S. successfully lowered high unemployment rates with aggressive monetary policy at the expense of small increases in inflation. Ball has proposed several explanations for this phenomenon, but here I focus on those that relate to the efficiency of the labor market matching function. In particular, Ball argues that the long-term unemployed may put less downward pressure on wages than those unemployed for a shorter period either because their search intensity decreases or because they are viewed as less able by employers. Below I argue that there is already evidence of a decrease in the efficiency of matching in the U.S. and that this has led to a moderate increase in the NAIRU. I will review a range of evidence on the hypothesis that prolonged periods of high long-term unemployment lead to an increase in the NAIRU and conclude that there is no strong evidence for this mechanism, but that the conjecture that it is at least a partial cause of the decline in labor market efficiency cannot be dismissed. Having not found a complete and convincing explanation for the decline in efficiency I turn to several other possible explanations to see what they might contribute. Extended unemployment benefits likely explain a significant part of the change and possibly the entire change. I argue that structural mismatch of the skills of the unemployed and the skill demands of available jobs probably has not contributed importantly to the growth of unemployment. Evidence on geographic mismatch does not suggest a role for it either, though it is possible that housing market problems could prevent labor mobility and increase the NAIRU in the future. I conclude with a discussion of the policy implications of the findings. What is happening to the Efficiency of the Labor Market and the NAIRU? Figure 1 shows monthly data for the rate of unemployment and a measure of the vacancy rate constructed from the Conference Board’s help-wanted index for the period 1980-1983 and annual average data for those same measures from 1965-1980. The unemployment rate and the vacancy rate from the Job Openings and Labor Turnover Survey (JOLTS) for the period 2001-2010/7 is also presented where the JOLTS vacancy rate has been adjusted to be compatible with the vacancy rate from the help-wanted index.1 Beveridge curves for the 1980-1987 and the 1954-69/2001-09 periods are also drawn. In models of frictional (Blanchard and Diamond 1989, 1991) or mismatch unemployment (Shimer 2005) the Beveridge curve is derived as the locus where the number of jobs being filled is equal to the number of new unemployed and the number of new jobs becoming available. On this curve both the unemployment and vacancy rates remain constant so long as the rate of new job creation and the inflow rate of new unemployed stay constant. The position of the Beveridge curve is often interpreted as a measure of the efficiency of worker-job matching. The further the curve is from the origin the more unemployed there are with the same number of available jobs. The Beveridge curve relation fits remarkably well for long periods of time. In each of the periods for which the curves are drawn, monthly data on vacancies and unemployment remained remarkably close to these curves. 1 See Dickens (2009) for an explanation of the method. Figure 1 Historical Beveridge Curves 11 12/1982 10/2009 1980-1987 4/2010 10 9 3/2011 1975 12/1983 8 1954-1969 1976 19771980 7 12/2008 Unemployment rate 1978 6 1971 1974 1/1980 1979 1972 1970 5 1973 1965 4 1/20 1966 1967 1968 1969 3 0.75 1.00 1.25 1.50 1.75 2.00 2.25 2.50 2.75 3.00 3.25 Job vacancy rate Starting about two years ago the vacancy rate began to rise while the unemployment rate remained mostly unchanged.2 The last time there was a sustained increase in the vacancy rate, at similar levels of unemployment was during the 1970s. That rise coincided with a period during which it is widely believed that the NAIRU increased. Similarly, during the late 1980s and 1990s the level of vacancies that coexisted with a particular level of unemployment fell and this coincided with a period during which most estimates suggest that the NAIRU fell (Gordon 1987, Staiger et al. 1997). In Dickens (2009) I developed and estimated a model of the Beveridge curve and the Phillips curve that links movement in the Beveridge curve and the position of the long-run Phillips curve or NAIRU. The results from estimating the model suggest that all shifts in the NAIRU in the U.S. result from changes in the efficiency of worker-job matching as reflected in movements of the Beveridge curve. Using this model I can determine the implications of the recent increases in the vacancy rate for the NAIRU. Figure 2 presents quarterly estimates of the NAIRU from the model going back to 1960. It suggests that the last two years have seen a notable increase in the NAIRU from 5% to just under 6%. Similarly, when I estimate a model allowing for downward nominal wage rigidity to affect the inflation-unemployment trade- off as in Akerlof et al. (1996), I find that the lowest sustainable rate of unemployment rises from 3.9% to just under 5%. There is some variation when I estimate different specifications of these models but all suggest that it would be possible to lower unemployment by at least 3 percentage points without risking substantial inflation. 2 In April there was a large increase in the vacancy rate that should probably be ignored as it was mainly due to government hiring for the Census. But, even ignoring that month, there is still a noticeable increase in the vacancy rate over the last year. Figure 2 NAIRU with 90 % Confidence Interval (1960 - 2011) break 1997:4 2001:1 12 10 8 6 NAIRU (percent) NAIRU 4 2 0 1960 1962 1964 1966 1967 1969 1971 1973 1974 1976 1978 1980 1981 1983 1985 1987 1988 1990 1992 1994 1995 1997 2002 2004 2005 2007 2009 2011 While the model interprets the increase in vacancies as indicating an outward shift in the Beveridge curve, there are several reasons to question whether the Beveridge curve really has shifted out.
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